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A call for restraint in light of economic clouds ahead

There is a recession looming and Oregon is, once again, ill prepared to deal with it. No, I’m not an economist or a market analyst, or, for that matter, I didn’t even stay at a Holiday Inn Express. But a friend of mine, Jim Stack, President of Investech and a nationally know bear market analyst who has been dead on during the last two recessions, is an expert. Without resorting to the myriad of charts and indices that Jim uses in his thoughtful and articulate analysis, suffice it to say that he concludes that the storm warning flags are flying and that we may, in fact, have already entered a recession. (A recession is defined as two consecutive quarters of declining Gross Domestic Product (GDP) and, therefore, you are already a half year into a recession before it is labeled as such.)

At the close of business of the day of this column, the Dow Jones has dropped just about 1200 points from its September highs. That is an 8.5% drop in the market. More importantly, that means that year to date, the stock market has grown precious little and, therefore, capital gains — the mother’s milk for tax revenue growth in Oregon — has grown very little also. And in a recession capital gains revenue will shrivel to near zero — just like it did during the last recession.

So why is that important. Well for two reasons.

First, Gov. Kulongoski has announced that he is “backing away” from consideration of tax reform because the current tax structure appears to be sufficient to provide all of the tax revenues necessary for the future. Now the future to Kulongoski means that spending will increase in excess of twenty percent or more each biennium. Kulongoski and his Democrat colleagues in the legislature are prepared to demonstrate that fact in spades during the upcoming special session when they will add millions to the already largest increase in spending on record for the legislature.

The recent recession which Oregon entered almost six months before the rest of the nation and exited nearly a year after the rest of the nation, proved that there are insufficient revenues to sustain the double digit growth in spending that preceded that recession. And there is no reason to expect anything different in the face of a new recession.

Second, the revenue forecasting model used by both the Governor and the state legislature has a fatal flaw when it comes to economic activity on the edges of “normal” growth. The model uses a straight line growth assumption based on historic “average” growth. Thus, the model assumes that from whatever economic condition exists at the time, there will be growth from that point. During the 2001-2003 legislative session(s) — there were five special sessions in addition to the regular session — the forecasting model consistently failed to predict the decline in revenue for the ensuing period because it was biased towards growth — thus the need for five special session to rebalance the budget in light of continuously declining revenues. The best the model could do was predict growth from a new, lower base.

It is the same reason that the model failed to predict a nearly $1 Billion surplus in revenues for this past year resulting in the extraordinary (and well deserved) refund due to the “kicker.” In essence, the kicker is triggered when actual revenues exceed predicted revenues and since the model predicts average growth from the most recent base of revenues collected it cannot predict robust growth.

The end result is that Oregon finds itself in exactly the same situation that it was in prior to the most recent recession and resulting economic and government turmoil. We have a government biased toward excessive spending and a revenue forecasting model incapable of predicting the advent of a downturn, or the depth of the downturn when it occurs.

But the extent of the problem is not the same. Prior to the last recession, Oregon experienced an extended and strong period of economic growth with an expansion of good paying jobs. Currently, we have barely recovered from the previous recession and while there has been job growth it has largely been in the government and service sectors. The manufacturing and construction sectors (the good paying jobs) have declined and we continue to watch the out-migration of substantial businesses.

For those in office who believe in responsible government, it is time to put on the brakes. And while you cannot stop Kulongoski and the Democrats because of their numerical majority, you can refuse to be a part of it and you can scream loud and clear each and every day for reform of the forecasting process and restraint in spending.